New challenges, uncertainty on horizon for automotive industry

ANN ARBOR, Mich.—The automotive industry has dug itself out of the Great Recession, but there's plenty of uncertainty on the horizon.

Light vehicle sales in the U.S. have grown every year since bottoming out in 2009, eclipsing pre-recession highs of 16 million-plus in the last three years. While 2017 still is projected to flirt with the 17 million mark, something the industry has achieved only four times before, early figures suggest demand in the U.S. is leveling off.

The industry has produced back-to-back years of record light vehicle production at 17.48 million in 2015 and 17.53 million in 2016. But the year-over-year growth looks to be coming to a halt based on figures through the first five months of 2017, which are off by about 2 percent compared to 2016. Most forecasts called for the industry to post another 17 million in light vehicle sales, but the seasonally adjusted rate through May has the industry missing that mark narrowly—at about 16.8 million units.

"Overall vehicle sales for the U.S. are plateauing, without a doubt," said David Andrea, executive vice president of research at the Center for Automotive Research.

"It will get harder to make year-over-year comparisons. The one positive piece in here is exports, that's where keeping the NAFTA sourcing platform in place is so critical for the cost positioning for the North American industry. For the industry overall, it really becomes an issue of mix between cars and trucks. Even if you have a flat or slightly down top line, you can have segments that are still growing in that environment. Who your customer is and what platforms you're on becomes that much more critical for a supplier."

Leveling off

As light vehicle sales level off, incentive spending and inventory levels continue to rise. For May, incentive spending averaged $3,583 per vehicle, up $241 from May 2016 according to a report in Automotive News, a sister publication of Rubber & Plastics News.

The report also detailed climbing inventory levels with the industry's average increasing above 70 days for the first time since 2009. More than 27 percent of new vehicles sold in May sat on dealer lots for more than 90 days, also an increase compared to 25 percent in 2016.

Stephanie Brinley, a senior analyst for IHS Automotive who covers North and South America, said in an email that if auto makers carry excess inventory, they may slow production in the future.

Some auto makers are seeing inventories increase in part based on product lifecycle and production needs for later in the year, and in part on market performance. She added that auto makers have placed more focus on matching production to demand in recent times.

"We don't seem to be selling as many as we're making," said Jay Doyle, general manager for Trelleborg's North American automotive hub. "I'm a little bit concerned about the second half softening up. Unless they do some sort of a fire sale and start clearing out these lots, I can see adjustments coming in the second half of 2017. I don't know if we're going to hit that 17 million mark that everyone expected."

Andrea said the industry is more disciplined than it has been in cycles past, citing that the number of units per hour are being pulled back to ensure production stays balanced with inventory levels.

Once levels start reaching 70-plus days on the lot on any one nameplate, Andrea said actions will be taken to incentivize the market in combination with production being rationalized to close the gap.

"This is where suppliers can get caught in these inventory adjustments," he said. "The danger always is building to production schedules that make one quarter look really strong only to have production schedules cut in the next quarter to adjust inventories, and that's what puts a hole in the business plan of any supplier."

CAFE revisited

The Trump administration clearly has signaled its intent to make changes on the regulatory front. How effective it will be remains to be seen.

For starters, he's ordered the Department of Transportation and Environmental Protection Agency to revisit the previous administration's rule that finalized increased corporate average fuel economy standards to the equivalent of 54.5 miles per gallon for cars and light-duty trucks by model year 2025.

Andrea said the industry will focus on how the new administration harmonizes the requirements between fuel efficiency objectives and greenhouse gas emission reduction standards so they are not in conflict with one another.

"I don't think anything drastic is going to happen," Doyle said. "It took a long time to develop those standards for now and for the future. I don't think an executive order is going to change that in one fell swoop. Anything that the government gets involved in is going to take some time. There's just too much push back and conflict between the political parties that isn't going to allow that to happen in a compressed time frame. I don't think there are huge changes coming. I know the new administration would like to see some huge changes to spur the industry, but I just can't see it happening fast."

Freudenberg Group CEO Mohsen Sohi said in an email that it is difficult to predict what changes might develop as the U.S. reviews its ruling. He added that the firm's customers still are ambitiously engaged in improving the fuel economy of their vehicles and Freudenberg will continue to support them accordingly.

Globally, however, Sohi said all other major automotive markets are pursuing tougher emission standards.

"While the specific mechanisms and control strategies may differ, the end objective of each region is dramatically lower (carbon dioxide) emissions focused on achieving established targets between 2025-30," he said. "One risk of a potential significant rollback of the current regulations is that it could slow down the momentum or innovation and isolate the U.S. from a technology and development perspective."

The industry still will have to balance between satisfying CAFE requirements and satisfying customer demand for bigger, less fuel-efficient, vehicles.

"It's a constant juggling act that all the vehicle manufacturers need to play with," said Andrea, who highlighted a few ways OEMs are striking a balance. Most recently, he said Ford disclosed its intention to expand electric vehicle powertrain offerings, including on some of its existing nameplates like the Mustang and F-150 pickup truck.

"Without a doubt within the Mustang you might be able to package that electric powertrain to deliver on performance and drivability, and the types of attributes that Mustang drivers buy that vehicle for," Andrea said. "It may be more difficult to deliver those attributes for an F-150 buyer because those attributes are more for trailer towing, utility and torque. It will be interesting to see how they can get additional fuel economy out of an electrified F-150 powertrain."

Suppliers will need to be more flexible in their production because as gasoline prices vary through a model year, the powertrain take rates may vary significantly.

Sohi said while the U.S. customer base still wants bigger vehicles, "these larger vehicles are cleaner and more efficient than at any other time in history. Top auto makers have leveraged advanced technology developments for improved fuel economy on a global scale to help consumers get what they want—larger vehicles and improved fuel economy."

A new deal?

President Trump also has not been shy about his disdain for the North American Free Trade Agreement. While the president was more forceful in his desire to scrap the agreement during the campaign, since taking office the administration has backed off a bit, but still intends to renegotiate the deal.

"I don't think the NAFTA agreement can be scrapped," Doyle said. "I don't think the administration wants to scrap it any longer. I think there's going to be a re-negotiation of NAFTA, but not just backing out. There's too many other parts of the agreement that can hurt other industries."

Renegotiating the agreement won't be an easy task and will require the administration to balance the needs of several other industries with that of automotive, which alone has many moving components.

Sohi said Freudenberg and its fellow members of the Motor & Equipment Manufacturers Association are actively involved in working with the Trump administration in its efforts to renegotiate. Changes being proposed by MEMA include: reviewing and tightening the rules of origin utilized to qualify automotive goods under NAFTA; harmonizing import and export data requirements and processes; and ensuring that U.S. safety, emissions and other applicable standards are mutually accepted.

"As a globally active technology group we see value in free trade agreements," Sohi said. "Eliminating NAFTA without replacement would result in tremendous upheaval in international supply chains related to the automotive industry. Long-term stability of the trade agreement is imperative for making strategic long-term investments in the region."

OEMs have built their export market based on the availability of components coming in from Canada, Mexico and other international markets. Andrea said looking at North America as a whole, the production base is on a volume level that rivals Europe and China.

"NAFTA gives us the scale to compete," he said. "Any renegotiation still needs to address this."

Hurdles to automation

Autonomous vehicle technology looks to be one of the biggest disruptions to the automotive industry, but when that horizon will arrive still is a bit murky.

Doyle said for the most part the technology is there to do it, but key challenges include concerns over infrastructure, liability and other legal issues. Brinley said the technology for fully autonomous vehicles to interact in all situations is not yet fully developed. Firms still are working to implement detailed mapping as well as vehicle-to-vehicle and vehicle-to-infrastructure technology.

So far the automated cars permitted on public roads are not fully autonomous. Sohi said it is likely that fully autonomous vehicles will first appear on highways by the mid-2020s because city traffic entails a whole new set of challenges.

"We do see autonomous driving as an industry game changer," Sohi said, "but when it happens, how it happens and what kind of impact it will have on the industry are the unknowns at this point in time."

From a rubber product perspective, the supply base may have to adapt to capitalize on new opportunities. Autonomous cars will have more sensors and electronics, and Sohi said this would provide new business opportunities for suppliers like Freudenberg in the areas of housings, gaskets and seals for these sensors and electronics.

Brinley added that most vehicles focus on sensors and software, but components like door and trunk sealing materials still are expected to be needed.

"When you look at the number of rubber parts in a drivetrain today versus the drivetrain of tomorrow with respect to e-mobility, the number of parts the rubber industry would supply is drastically reduced," Doyle said. "The complexity of those systems from a mechanical perspective is reduced significantly. All the major rubber suppliers are still trying to discover what is going to be available. Even if you just look at the fuel system on a conventional drivetrain or powertrain, it's gone. It switches over to electrical."

Automotive News contributed to this report.